LSI Industries Inc. (LYTS) Earnings Call Transcript & Summary

Greetings. Welcome to LSI Industries Acquisition Update Conference Call. [Operator Instructions] As a reminder, this conference is being recorded. It is now my pleasure to introduce Jim Galeese, Chief Financial Officer. Thank you, sir. You may begin.

Welcome, everyone, and thank you for joining today's call. We issued a press release after market close yesterday announcing LSI Industries' acquisition of Canada's Best Holdings. In addition to this release, we also posted a conference call presentation in the Investor Relations section of our corporate website. Information contained in this presentation will be referenced throughout today's conference call, included are certain non-GAAP measures for improved transparency of our operating results. Please note that our commentary and responses to questions on today's conference call may include forward-looking statements regarding our business outlook. Such statements involve risks and opportunities, and actual results could differ materially. Please refer to our safe harbor statement, which appears in the transaction press release for more details. With that, I'll turn the call over to LSI President and Chief Executive Officer, Jim Clark.

Thank you, Jim. Good morning, all. We appreciate you taking the time to join us today, given the relatively short notice. After the market closed yesterday, we announced our acquisition of privately held Canada's Best Holdings, recognized in the market as Canada's best store fixtures for a cash purchase price of USD 31 million, $24 million paid at the time of closing and $7 million in a performance-based earnout. Founded in 2003, Ontario -- Canada's Best is a leading provider of retail fixtures and custom design solutions for grocery, quick-serve restaurants, C-stores, banking and specialty retail. From design to fabrication and installation, Canada's Best offers a vertically integrated build-to-order solution that spans the full project life cycle. Canada's Best is an established partner of choice for customers ranging in size from small regional chains to national and international brands with hundreds and thousands of sites while supporting its customers from 3 strategically located marketing and production distribution facilities in Ontario and Alberta, Canada. Canada's Best represents our third acquisition within the custom display solution market in the last 4 years and is highly complementary to LSI, JSI and EMI, EMI who was acquired in April of last year. At a strategic level, we believe this transaction makes a compelling story across multiple dimensions. First, at a strategic level, Canada's Best further positions LSI as a cross-border retail display solution business of scale, one equipped to support large brands across North America, both within existing and new vertical markets. To date, Canada's Best has either constructed or remodeled more than 10,000 customer locations, including those of large domestic brands such as [ Canada's Tires ], Shoppers Drug Marts and Pet Valu, in addition to brands like Starbucks, where they have supported site conversions over hundreds of locations in Canada. Second, at a geographic level, Canada's Best significantly increases our presence in the rapidly growing Canadian market, providing local product project capabilities for large retailers with store locations throughout Canada. Canada's Best will become LSI's largest business by revenue in Canada and one whose well-established, long-term customer relations are expected to provide significant revenue opportunities in the Canadian market. Third, similar to our previously completed JSI and EMI acquisitions, LSI shares minimal overlap with Canada's Best customer roster, creating the potential for significant commercial strategies. In fiscal 2024, approximately 80% of Canada's Best revenue was with customers not currently served by LSI. This opportunity is consistent with our acquisition playbook, and it creates great cross-selling opportunities. Fourth, Canada's Best further expands our vertical market presence within grocery, C-store and quick-serve restaurants while providing a compelling entry point into some new vertical markets. In fiscal 2024, approximately 60% of Canada's Best revenue was derived from vertical markets, where we do not currently have significant presence, including financial institutions and commercial banking and specialty retail. Canada's Best currently serves some of Canada's largest banks, including Canadian Imperial Bank, TD, Royal Bank of Canada and BMO. Fifth, Canada's Best expands our capabilities north of the border by providing local retail display fixtures and manufacturing capabilities for our Canadian customers. The addition of Canada's Best provides an additional 130,000 square feet of manufacturing and distribution logistics operations in Ontario and Alberta. We believe the local fulfillment capabilities provided by Canada's Best will support growing demand for our custom retail fixtures. Finally, we believe Canada's Best will be immediately accretive on both a margin rate and earnings per share basis. Canada's Best generated an adjusted EBITDA margin slightly above our trailing 12-month adjusted EBITDA rate margin. Remember, EMI, which we acquired last year, was accretive from a dollar perspective but slightly dilutive from a rate perspective. So Canada's Best will be a nice immediate add. In summary, our acquisition of Canada's Best represents another important strategic milestone within our Fast Forward plan, one that furthers our capabilities, our geographic reach and our vertical market focus as we continue to build a lighting and display solutions platform of scale across North America. With Canada's Best, we see the potential for significant cross-selling opportunities, given our combined solution set, by providing our customers with an integrated offering designed specifically for their unique branding and customer experience requirements. Our integrated portfolio of lighting and display solutions are state-of-the-art, creating a significant multiyear opportunity for our business and our shareholders. Canada's Best helps us build additional scale and expanded capabilities as we capitalize on growing high-value addressable markets in the years ahead. We are excited to welcome more than 120 employees of Canada's Best to the LSI family, including Bud Morris, CEO of Canada's Best; and Luisa [ Loffreda ], COO, for their senior leadership in our plan going forward. As one team, we look forward to further advancing our strategic focus on profitable commercial growth, continued operational rigor and disciplined return-driven capital allocation. With that, I'm going to turn the call back to Jim Galeese for a few minutes for a financial review of the transaction. Jim?

Thank you, Jim. As Jim just shared, Canada's Best is a strong strategic fit for LSI, immediately expanding our presence in the Canadian market and providing the platform to accelerate growth in both our targeted vertical markets as well as broader fixture applications. Next, a few comments on Canada's Best historical financial performance, which are disclosed in U.S. dollars. In recent years, the company has delivered solid, consistent organic growth in revenue, operating income, adjusted EBITDA and free cash flow. During the last 2 fiscal years, Canada's Best generated average annual sales of $24 million and average adjusted EBITDA of $4 million. Both strong project price discipline and efficient operations contribute to the solid quality of earnings. The transaction is expected to be immediately accretive to LSI on both a margin rate and earnings per share basis. As mentioned, we see synergy opportunities both commercially and in operations, leveraging the strengths of both LSI and Canada's Best. LSI funded the acquisition of Canada's Best utilizing cash and availability under our existing $100 million credit facility. At closing, we anticipate that our pro forma ratio of net debt outstanding to trailing 12-month adjusted EBITDA, including the TTM contribution from Canada's Best, will be approximately 1.1x. We intend to significantly reduce net leverage within the business during the next 24 months, supported by anticipated growth in pro forma free cash flow from the combined entities. Looking forward, retention of the strong management team led by Bud and Luisa, as Jim just introduced, combined with long-standing valuable customer relationships and the broad proven integrated solution capabilities, all provide the framework for ongoing successful business execution and profitable growth. Canada's Best Store Fixtures will remain an independent brand, given its established commercial presence in the market, and will become part of LSI Display Solutions segment on a reporting basis beginning in the fiscal third quarter of 2025. With that, I'll turn the call back to the operator and open the line for questions.

[Operator Instructions] Our first question is from Aaron Spychalla with Craig-Hallum Capital Group.

First for me, can you just kind of talk a little bit about the process? I mean, I assume given your normal process discussions have been going for some time. Just can you talk about any changes along the way from some of the current events and the administration with tariffs and things like that? It sounds like that business is pretty self-contained.

Yes. Aaron, thanks for taking the time this morning. I know it was short notice, so I appreciate everybody taking the time to get on the call. Yes, I mean, we've talked about the process before. We put a significant amount of time into self-originating to going and looking for opportunities, not just waiting for them to come to us. So companies like Canada's Best and Canada's Best included are on our radar consistently and constantly. And sometimes, we're planting a seed that we're interested in the opportunity to talk, and sometimes a project like this goes through a process. I don't think that we've run into many that -- even if we kind of broached the idea, don't end up with some type of banking representation, and this one did -- also Bud and Luisa had a banker involved. We've been engaged with them for quite some time, I want to say, almost close to a year. So the current ups and downs with tariffs and cross-border and all of that didn't really factor a lot into our long-term consideration. When we had looked at Canada's Best, we had recognized the synergies in the place where they would play. And as we've talked about before, we look at more than just a financial view. We look at the financial view, we look at the commercial view. But we also look at the cultural fit. And I have to tell you that's such an important element for us, and Canada's Best really fit in that cultural aspect. So short answer to your question is we've been looking at them for some time, we've been in discussion for some time. We thoroughly reviewed the potential impacts of these ongoing tariffs and tension. But we do believe Canada's best can be completely stand-alone within Canada and serve that market. And the U.S. LSI, EMI, JSI can completely serve here in the U.S. market. And when or if there's opportunities across the border to move products, we'll certainly take advantage of that. But if there's tension or friction or tariffs that make that unattractive, Canada's Best can support itself wholly contained within Canada and LSI can continue to support itself wholly contained within the U.S. and other markets like the islands and Mexico and others, even with the tariffs in place or as they increase or whatever it is.

All right. And then you talked a little bit about the commercial synergies. Just curious, the historical growth rate of that business, and just how you kind of see that playing out here going forward? And just any large customer concentration to note?

Yes. No large customer concentration to note. Nobody that represents really double digits for any kind of 1- or 2-year period. They have high single-digit growth, and we think that we can -- as a combined company, there's opportunities to grow even faster. They have had times where they have grown double digit, and they've had times where they've grown lower single digit. But on average, over the last 5 years, they've done a very good job of maintaining high single-digit growth. So we're excited by that. And I did mention it in my comments, but they bring us into a couple of new vertical spaces, particularly the whole retail banking side, where they do interiors of bank -- retail bank facilities, but they also do a lot around facades for ATM vestibules, outside ATMs, lobby ATMs, things like that. And they have a really unique approach of having the whole facade kind of preconstructed and being able to be tilted up in the field, so it minimizes any downtime or disruption. And that's something we've leveraged for a long time, which is the whole idea of being able to come into a store or facility and really minimize the disruption to their daily operations. So that fits very well, and I think it was -- it's a very innovative approach they have.

All right. And then maybe one last question. Just on the broader pipeline, can you talk a little bit about what you're seeing from a valuation and activity perspective? Any kind of areas you might be looking at specifically here as we move forward?

You mean in regards to additional M&A activity?

Correct.

Yes. Well, as we've discussed before, we're pretty disciplined buyers. We're -- we want to look for that cultural fit. And if the cultural fit is there, then I always feel like we can paint a picture of what we can do together as opposed to just bolting on and having another piece in the pie. I will say that we're always going to be disciplined buyers, we're going to look at what the market is driving for valuations and stay competitive. But it's unlikely we're going to be in a position where we're overpaying for something. It's just -- there's too many elements, there's too many people involved in our company, there's too much at risk. So I would say that we're always -- we're value shoppers. How is that? We're looking for places where we can create value and where the company is a good fit. And I think we're competitive, but we're also looking for the right balance between the price we're going to pay and the value they give to our company.

Our next question is from Sameer Joshi with H.C. Wainwright.

Congratulations on the nice acquisition here. It seems the EBITDA is quite robust, and I guess it has been historically for the company -- for the sort of Canadian (sic) [ Canada's ] Best. Is there any reason for that in terms of like do they have operational efficiencies or do they have niche markets, maybe products that are unique? What is the reason for these robust margins?

Well, I wouldn't say their margins are out of line with LSI's performance on any particular segments or anything like that. They do serve another vertical market, a different vertical market, which was that retail banking side, which may drive a little bit higher margins that way. It is a different market, it's a Canadian market versus our typical comparative, which is the U.S. market. But I do want to underline they're accretive from a percentage and a dollar perspective, but not significantly. I think I even used the word slightly accretive. So it's just -- they run a good operation. Bud and Luisa do a very good job up there as well as the whole team. They have some pretty innovative approaches to things, one of which I just mentioned. The whole idea of being able to come in and have a preconstructed facade, which they're able to deploy in the field very quickly, all of those help them manage some of their installation costs and things. But I would say that generally, it's a combination. First of all, they run a good ship. Second of all, they serve different markets, which may just have a higher margin profile. And third, they have some innovation, like I said, where they have come up with some ideas to deploy in a way that is a little bit quicker and more effective. And I think that speaks a lot to their customer relations and things that they've done in the past.

Understood. So -- and then turning around, once the company is integrated, how do you see further synergies or further efficiencies to materialize? Do you expect margin expansion by growth? Or can there be other ways of expanding margins by like combining back office or that kind of operational efficiency?

Yes, absolutely. I mean, we see a whole bunch of opportunities just like we normally do. This is one where we talk specifically about EMI going to benefit from procurement and kind of strength that we have in our operational platforms, spaghetti diagramming, lean principles, things like that and their manufacturing processes, reducing waste, all of those. Canada's Best will benefit from all of those also, we see opportunities across that. We certainly see purchasing synergies just based on volume and strength of the combined companies. We do see equipment synergies, where maybe they have a piece of equipment that's fully automated and LSIs, JSI's product is less automated and then vice versa on some of that. I think that just like with EMI and JSI, these synergies will take time. We don't want to do anything that disrupts Canada's Best operations. We want to learn from it, and we want to bring some of the strengths and some of the disciplines we have while learning what they have. But we do see opportunities to improve in a number of different ways commercially and least of all -- not least of all, the commercial synergies, operational and commercial synergies. So we see a couple of different levers we can pull. Right now, our goal is to get them onboard, don't do anything disruptive, maintain the leadership that Bud and Luisa provide and the whole team executes against, and that's what's critically important to us.

Sounds good. And just one last one. I think very interesting that they have a presence in the commercial banking, financial institutions in Canada. Is that transferable to the U.S. like just by the product suite that they offer or services they offer that can help you expand in the U.S.?

Yes, the answer is absolutely yes, 100%. And like I said, they've been doing it for some time. They do provide services and have a very good reputation across all the major banks in Canada, including some of the smaller ones. And what they do is it's pretty innovative, their idea of being able to come in and just have a fully assembled facade and tilt it up right on site. It really minimizes the impact and allows them to deploy much more efficiently and it allows the customer to upgrade their image more rapidly and more often. So it fits right into our whole conversation that we've been talking about that what I refer to as the kind of the TikTok effect, which is it's a shorter attention span for many consumers. They want to see a store that's progressing at the same rate and speed that technology and other outside influences progress at. So that new look and feel, new image, refreshed images are very important to this growing customer base of ours. And our ability to do it more quickly, rapidly on site without impacting customers, impacting our customers' operations, times and then doing it economically; I think they're all kind of melding together for a very compelling story going forward. And we see that refresh cycle compressing, right, where it used to be 7 to 10 years, they would take a brand, a look, a feel and often the retailers or our customers would go with that look and feel for 7 to 10 years. We saw that compress from to 5 to 7 years, and we've seen it really compress now. It's really kind of aggregating around 5 years. So we're excited about it. And they bring some -- Canada's Best brings some pretty innovative ideas around that.

[Operator Instructions] Our next question is from Leanne Hayden with Canaccord Genuity.

Congratulations on the acquisition. So just a few quick ones from me. To start, can you provide any more detail regarding the performance-based earnout?

I don't want to provide a lot in this open format. But basically, it is -- there's a cash payment upfront. We have the $7 million on a performance-based earnout, and that performance is tied to the operation of the company, both from a sales and an earnings perspective. So I think it really helps align the team up at Canada's Best along with LSI's goals and objectives. So it's very fair, and it's one that we fully anticipate that the team [ warrant ].

Understood. Okay. And then in terms of upcoming acquisitions, is there a specific potential size of a company that you're targeting? Or do they have to be immediately accretive? Or are you targeting anything like that?

Yes. I mean our M&A strategy is one where we've been working on it for years, and we continue to put a lot in the top of the funnel. I mentioned a few minutes ago that we do a lot of work on self-originating, meaning going out and trying to create relationships with companies that we find interesting that we think would be -- would fit very well within our company. We do that so that we can learn more about the company and create a personal relationship in advance of any kind of financial transaction and understand that piece around culture that's so important to us. We just don't want to meld up with a company that just views the world so differently than we do. We just feel like that's -- not that we're opposed to a different view, we just want to have -- we want to look for a culture that's aligned with what we value. In terms of size, I've talked about this before. I mean I do think this is -- this fits for our Canadian operation, but it is more -- is definitely on the smaller size of what we would normally pursue, but we saw it as a good fit, given Canada's market is a bit smaller than the U.S. So it makes sense that the opportunities might be a bit smaller. EMI represented a company that was closer to $100 million. But as you just touched on, they were not accretive. They were accretive from a dollar perspective in EBITDA performance, but dilutive. But through our operations capabilities and our ability to kind of get in and introduce lean principles and things like that, we are very confident we'll bring their performance up to our level. And we've talked about that before. So summary is, I think that Canada's best represents kind of the smaller side of what we would do. I think that we will look for acquisitions in two flavors. One is bolt-on, we'll say, $100 million and less within our existing credit facilities. And then the other flavor is more transformational, something that might bring a significant scale. Let's just -- to put numbers to it, let's just say $200 million or something like that. But we would use the same discipline we've had with the acquisitions we've done so far to make sure that they fit culturally, that they fit from an economic standpoint, that the commercial opportunities are there and that the combined companies create a greater value than the stand-alones would. So it's -- I would just say we have our eyes open across the scale, but we're very disciplined about what we're going to do. And we want to make sure that the combined -- the combination of the two brings value that's higher than the stand-alone value of either.

We have reached the end of our question-and-answer session. I would like to turn the conference back over to Jim Clark for closing remarks.

Well, thank you again, everyone, for joining us on the call. It's part of our process. If we're going to do M&A, we're going to create this opportunity to have a call and get questions right from the market right away. I think Canada's Best is a compelling bolt-on acquisition for us, one that checks all the boxes around strategic fit and synergy and potential financial results. We remain very disciplined in our approach to scaling the business through inorganic growth and pursuing quality management teams and businesses that align with our cultural focus on shareholder value and business value creation. Our core business continues to perform very well. And with Canada's Best serving as another potential catalyst for growth, that puts us well on pace to achieving our long-term financial targets, as we've outlined in our Fast Forward strategy. So I would just want to say thank you again, and have a good day.

Thank you. This will conclude today's conference. You may disconnect your lines at this time, and thank you for your participation.